Where Does Oil Go From Here?
Managing Director Tom McNulty discusses the future of oil.
It is always good to start with the fundamentals of supply and demand. In terms of supply, crude oil reserves are still very large. The International Energy Agency (IEA) estimates that there are 1.6 trillion barrels of oil across the globe. In the United States, the Energy Information Administration (EIA) published that there were 38.2 billion barrels of proved oil at the end of 2020. In terms of demand, however, the picture is more complex. This is largely because the developed world is experiencing a flat or very low single-digit growth rate for crude oil demand, while the developing world is seeing meaningful demand growth. In fact, 90% of current global oil demand growth is from Asia, per the IEA. The table is set for a new era for oil, based on these themes.
First, Asia creates a natural hedge that underpins crude oil demand, such that supply will continue to be made available. The developing world has shown little appetite thus far for strict adherence to the various climate frameworks. Instead, the governments in developing economies naturally seek affordable economic growth and a higher standard of living. This might cause oil pricing to migrate to non-USD transactions. While the growth of electric vehicles (EVs) will impact the demand for oil and refined products in the developed world, it remains to be seen how fast and far EVs can expand in developing countries. And just as the search for oil when oil prices were high led to discoveries of large reserves of natural gas, so too will the search for more natural gas serve to uncover more crude oil reserves.
Second, the war in Europe highlights the importance of energy security and diversification. The US oil complex presents a perfect storm of technology innovation, ESG considerations, capital discipline, and skills that mean it can and should take market share. This will help to stabilize global oil markets from disruptive geopolitical shocks. I think there will be heightened awareness of capital flowing to regimes that are not good actors, because this has an Environmental, Social, Governance (ESG) impact, both the “S” and the “G.”
Third, there is an often-overlooked point about oil and the energy transition. Oil can fund a great deal of the energy transition. Current cash flows from crude oil are already being deployed by large energy companies to fund the development of clean and renewable energy. There is a growing push here in the US for the certification of “green barrels,” meaning oil produced from wells that have very tight air and water controls on them. Also, while the oil industry may not agree, many of the historical investors in oil and gas presume that oil will largely disappear as a transportation fuel in the next decade, and they are therefore concerned about “terminal value” or the ability to recover their investments in later years. US shale drilling, with its much faster recovery of capital, is far more appealing than the nearly decade-long capital recovery periods for many potential international oil and gas developments. Any effort to fill the gap between demand and currently constrained supply may depend largely on US oil and gas companies and their ESG-conscious investors, both of which would need to be on board. Old energy can be a source of capital for new energy.
So, what does it mean? The ESG movement will mean that better players or stewards in the oil business will draw capital away from bad players. The M&A market in the oil industry should accelerate, from large caps all the way down to small caps, as there is a shuffling of assets and industry consolidation. I expect more capital to flow back into the oil business for all these reasons, and it is already happening.
Tom McNulty’s thoughts have been featured in the Houston Chronicle. Read the article here.